Alternative Minimum Tax Reviewed - Proposal 2 | ECON 150, Assignments of Public finance

Download Alternative Minimum Tax Reviewed - Proposal 2 | ECON 150 and more Assignments Public finance in PDF only on Docsity! Economics 150, Policy Proposal 2 S. Mirkin, S. Kustu, M. Kanagak Alternative Minimum Tax Reviewed Background The Alternative Minimum Tax was introduced in 1969 to establish minimum tax liabilities for wealthy individuals. It disallowed many tax deductions to prevent America's wealthiest from sheltering their incomes excessively. With time however, the burden of AMT has fallen increasingly on the middle class. To make matters worse, the Tax Reform Act of 1986 made changes to AMT policy that broadened its base further into the middle class. Those hit hardest were parents, homeowners and residents of high tax states. AMT is a parallel taxation system under which taxpayers calculate their liabilities using standard income tax rules and AMT rules – taxpayers, whose liability exceeds their standard liability, pay taxes on the difference at AMT rates. AMT is a two tiered system with rates of 26% and 28%, and includes exemptions intended to keep middle-income taxpayers out of its reach. However, AMT is not indexed to inflation, so it impacts the middle class increasingly with time. By 2010, approximately 92% of taxpayers making between $100,000 and $500,000 will fall, under AMT, but only one third of those earning over $1 million will be subject to it. About 5.7 million married couples will face AMT just because they have children – 97% of them making between $75,000 and $100,000. Families earning $75-100K will be 18% more likely to be on AMT than those earning over $1 million (taxpolicycenter.org). Solutions AMT only marginally addresses the loopholes in income taxation, yet does so at great expense to the middle class. For years, Congress has passed one-year patches to prevent AMT from affecting more people, but these patches are inefficient and costly if congress does not compensate for lost revenues elsewhere (e.g. by raising another tax). It is clear that AMT must be permanently reformed or eliminated entirely, but eliminating AMT could cost government more than $1trillion in revenue over 10 years (assuming no patches). A comprehensive solution must be revenue neutral, raising taxes elsewhere to cover its cost. It is equally important that reforms to the tax system do not adversely affect the distribution of tax burdens. AMT was not originally intended to shift tax burden away from the middle class, just to prevent a small group of individuals from avoiding taxes. However given that AMT now affects many taxpayers, AMT reform could significantly affect the distribution of tax burdens across incomes. We present two options below: The first would have substantial distributional impact while the second would not. 1) Repeal AMT, Increase Top Income Tax Rates Our first proposal is to repeal AMT and offset revenue losses by increasing standard income taxes by 15% on taxpayers in the three highest income brackets. This would have greatest impact on the highest 10% of earners. Increases for the top 1% of earners would be almost 3% of their incomes after 2010 (when the Bush tax cuts expire). Revenue Neutrality The proposed policy would result in some loss of federal tax revenue through 2010 when the Bush tax cuts expire. However, after 2011 the federal government would enjoy significant increases in tax revenue ranging from 16 to 30 billion dollars annually. The proposal is likely to maintain revenue neutrality well into the future. Economics 150, Policy Proposal 2 S. Mirkin, S. Kustu, M. Kanagak Equity Increasing tax rates in the highest income brackets would shift tax liability to a few high income taxpayers, but it would provide relief to many in the middle and upper-middle classes. The wealthy would be most likely to benefit from repealing AMT, so they would not be unfairly burdened by facing higher income tax rates. Meanwhile, Americans below the 80th percentile for cash income would see both immediate and long term tax relief. Those above the 80% percentile would see eventual tax increases after the Bush tax cuts expire in 2010. Efficiency Eliminating the AMT would significantly simplify the tax system, and thus reduce administrative costs and improve efficiency. Offsetting revenue losses by raising taxes on top income brackets would relieve undue tax burdens on the middle class, while maintaining revenue neutrality. 2) Repeal AMT, State and Local Tax Deduction, & Adjust Top Income Tax Rates with No Change in 2011 Undoubtedly, the repeal of AMT will have to come at a significant increase in income rates. This, however, can be done without raising or lowering taxes in the aggregate through offsetting income tax changes. These income tax changes would shift tax liability among some taxpayers but would not create a net tax increase as long as the level of aggregate receipts is held at or below the Corrected Baseline.[1] Taxpayers lose some income tax deductions in calculating their AMT liability. One such deduction is the state and local tax deduction. The projected steady rise in AMT receipts is due in part to the AMT's steady repeal of the state and local tax deduction. Eliminating the AMT and offsetting the revenue effects by phasing out the state and local tax deduction would have other important advantages as well: it would offer significant, real simplification of the tax system by eliminating the AMT altogether without significantly changing effective marginal tax rates. In other words, we believe there is no reason to allow revenue-neutral AMT reform to produce significant shifts of federal tax liability among taxpayers. Source: taxpolicycenter.org The net effect of this policy will be in the increase for top three income tax rates by 2% in the short-term (thereby paying for the repeal), but creating the long-term incentive for wealthy individuals to 1) bring foreign- vested money back to U.S., 2) and decrease excessive claim of state deductions. Since AMT itself only partially succeeded in reinforcing taxation, phasing out of state and local deductions will be an effective reinforcement on higher income. States that impose lower tax burdens on their citizens also have fewer citizens subject to the AMT. These low-tax states also tend to have fewer citizens choosing